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What China Can Learn From 19th Century U.S.

  • U.S. economy underwent a similar transformation a century ago
  • Chinese growth hinges on industrialization and urbanization

China’s shift from super-charged economic growth to a more moderate pace has drawn plenty of comparisons, most often with Japan, which lost its economic dynamism as its population aged, asset bubbles burst and export prowess faded. Some China perma-bears even predict a Soviet Union-style unraveling. 

But there’s another, less obvious historical model: late-19th century America. That’s right, the U.S. of the post Civil War-era, a period of rapid economic transformation fueled by massive investment, technological change and population migration to the cities. There were ups and downs, but over the sweep of history the U.S. grew to become the world’s biggest economy, a mantle China wants to capture in coming years.

"The rise of the U.S. in the 19th century is comparable, in its dominance and speed, relative to the rest of the world," said Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former International Monetary Fund economist. "Judging how the rise of China has thus far affected the rest of the world, the closest comparison could be the U.S. a century ago."

Building Boom

In both cases, living standards soared as massive infrastructure projects and a building boom created jobs, while private enterprise had a pool of plentiful and cheap labor to draw from -- in the U.S. case fueled by millions of immigrants, and in China’s by its vast rural population. Just as new railroads opened America’s West to settlement and development and transported goods at faster speeds, China built the world’s largest high-speed rail network over the past two decades.

China’s communist leaders, while dousing plenty of bush fires over the past 40 years, have so far managed to avoid the sharp peaks and troughs that marked the U.S.’s Gilded Age, Roaring Twenties and Great Depression.

The U.S. historical parallel is unlikely to surprise China’s history-obsessed leaders, who on Wednesday wrapped up their annual gathering of the legislature. At the start of the conclave on March 5, Premier Li Keqiang spoke of the need to avoid the "middle income trap," which has snared so many developing nations before they grew rich.

Yet even after almost four decades of breakneck development, the world’s second-largest economy remains decades behind the biggest on many metrics. While its population became majority urban in 2011, the U.S. crossed that threshold sometime between 1910 and 1920.

"There’s much room for us to boost industrialization and urbanization represents the largest source of China’s domestic demand," Premier Li said Wednesday. "In China’s central and western regions there is enormous room for more effective investment propelled by the twin engines -- that is the new growth drivers and upgraded traditional growth drivers."

And while its gross domestic product may eclipse that of the U.S. in coming decades, on a per person basis it remains generations behind.

One reason historical parallels with Asian economies like Japan and Korea are flawed comes down to size. While both nations could ride an export-led strategy all the way to a Western level of prosperity, China’s $10-trillion plus economy is too big to rely on overseas demand as its main growth driver.

Like the U.S., China is a continent-sized nation that must rely on domestic demand for a more balanced road to development. That’s why policy makers want consumption and services to grow and for private entrepreneurship to play an increasing role.

As part of that strategy to transition the economy and remove deflationary overcapacity, authorities plan to shutter coal and steel plants and shift workers into new, more productive areas. That’s similar to the growing pains experienced by the U.S. economy earlier in its development, and means the government will need to cushion the changes, said Alex Wolf, an economist for emerging markets at Standard Life Investments Ltd. in Edinburgh.

"Importantly, U.S. government policy helped ease the transition for workers through these dramatic shifts, which China is in the process of doing now," said Wolf.

President Franklin D. Roosevelt’s New Deal sought to offer some Keynesian support as unemployment reached as high as 25 percent. China today -- with urban unemployment one fifth those levels -- has already made it clear that where workers lose their jobs, compensation and alternative employment will be offered.

Significant Differences

To be sure, there are significant differences between the U.S. and China -- not least that the system of governance and legal structures are starkly different.

The limits of China’s ability to control its economy while allowing a bigger role for markets was exposed last year after policy makers were criticized for their bungled response to a $5 trillion stock market rout.

"The lesson China now offers is one we’ve seen before -- policies that lift a country from poor to middle class will probably not work to lift it from middle class to rich," said Derek Scissors, a scholar at the American Enterprise Institute in Washington who studies the Chinese economy. "For a country to be rich, individual property rights to rural land must be complete, labor must be able to move freely, most capital must be commercially allocated, and competition must be encouraged for the sake of innovation."

Policy Progress

The worry for Li and President Xi Jinping is that growth grinds lower before the goal of a "moderately prosperous society" is achieved.

"Just like the U.S. could only urbanize, reduce disease and infant mortality, and connect people via telephone and autos once, China has just wrapped up a similarly spectacular but unrepeatable economic transformation," said Andy Rothman, a San Francisco-based investment strategist at Matthews Asia. "It must now move on to a period of slower growth."

That is largely accepted, even by China’s policymakers who talk of a “New Normal" era of slower but more sustainable expansion. President Xi’s administration is boosting social safety nets so people can spend more, fueling the rebalancing toward consumption and services and away from investment and export-powered expansion.

History Buffs

China’s official media has looked to the historical lessons of U.S. economic development. In December, Xinhua News Agency warned that China must learn from U.S. policy in the 1980s and not boost the services sector at the cost of manufacturers.

"The United States is now trying to claw back the lost advantages of its industrial sector," Xinhua said. The news service went on to quote a warning by Alexander Hamilton, a founding father of the U.S., that a nation’s independence and security is materially connected with the prosperity of manufacturers.

"That judgment still holds true for today’s China," Xinhua said.

In a commentary this month, Xinhua cited former U.S. President Ronald Reagan and former British Prime Minister Margaret Thatcher for pushing through the kind of tax cuts and fiscal spending that helped fuel growth.

Box Office

On some metrics, China is catching up faster. Cinema ticket annual sales could overtake the U.S. as early as 2017 and outbound tourism is on course to reach 200 million by 2020 according to CLSA Ltd. For the nation’s patriots, its growing economic power is a return to the historic norm rather than a debt-fueled expansion destined for failure. 

Still, historical parallels will only stretch so far, and China faces a host of challenges -- from its debt load that’s already 2.5 times gross domestic product, to its aging demographics that threaten to turn it old before it grows rich.

"China’s scale and recent history, as well as its political system, are unique, so it isn’t possible to just plug the country into a simple model based on experiences elsewhere," said Rothman, previously a U.S. diplomat based in Beijing.

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